1

Published in European Company Law Journal, 2012

Is the Comply or Explain Principle a Suitable Mechanism for Corporate Governance

throughout the EU?: the Dutch Experience

Rients Abma and Mieke Olaerts1

1. Introduction

The consequences of the financial crisis have led to a renewed attention for corporate governance

issues and have increased the discussion regarding what constitutes good corporate governance. It is

against this background, in order to restore the public’s trust in the Internal Market, that the European

Commission launched its Green paper on the EU corporate governance framework in April of last year

(hereinafter: the Green paper or the corporate governance Green paper).2 The purpose of the Green

paper is to assess the effectiveness of the existing corporate governance framework within the

European Union.3 The purpose of the Green paper is to foster the debate regarding a diverse range of

corporate governance issues. These issues include amongst others: the composition, diversity,

functioning and role of the management board, the boards role in relation to risk management, the role

of shareholders and the way in which their active participation and interest in sustainable and long

term performance of the company can be encouraged and the application of corporate governance

codes to small and medium sized enterprises.

Another point for discussion which the Commission addressed in the Green paper which specifically

triggered our attention concerns the improvement and enforcement of the application of national

corporate governance codes. With regard to this last subject the Commission questions the effective

functioning of the comply or explain method within the EU corporate governance framework.

In this paper we will discuss the issues raised by the Commission regarding the functioning and the

effectiveness of the comply or explain rule in a Dutch context. We will use the Dutch experiences with

the comply of explain rule as a test case to discover its effectiveness in a European continental system

characterized by a stakeholder model. The comply or explain rule originates from a shareholder model

which was traditionally characterized by dispersed ownership. Our research allows us to draw some

conclusions with regard to the functioning of this rule throughout the European Union and the

measures that could be take in order to secure its effective functioning.

In the next paragraph we will first elaborate on the origin of the comply or explain principle after

which we will discuss some of the potential drawbacks of the use of this principle as they have been

described by the Commission in the Green paper as well as in academic literature. In the remainder of

the paper these drawbacks will be tested and compared to the experience with the comply or explain

principle within Dutch listed companies. From thereon we will make suggestions with regard to

1 Rients Abma is Executive Director of Eumedion, the Dutch corporate governance platform for institutional

investors and Mieke Olaerts is Assistant Professor at the Faculty of Law of Maastricht University and a research

fellow of the Institute for Corporate Law, Governance and Innovation Policies at Maastricht University. 2 The consultation on the Green paper was closed on 22 July 2011. The Green paper can be downloaded from the

website http://ec.europa.eu/internal_market/company/modern/corporate-governance-framework_en.htm. A

summary of the received responses and the feedback statement of the Commission can also be found on this

website. 3 Green paper, p. 2.

2

enhancing the effectiveness of the comply or explain system by designating the important players who

could be assigned a more elaborate role in the enforcement of corporate governance codes. These

suggestions can also be used to encourage the effectiveness of the comply or explain rule in other legal

systems. Our findings will be summarized in the conclusion.

2. Background and origin of the comply or explain principle

The promulgation of corporate governance codes within Europe is a national affaire and therefore each

Member State has its own code(s) of conduct. Nevertheless, the use of the comply or explain principle

throughout the European Union is promoted on a European level by Directive 2006/46/EC. This

directive requires listed companies throughout the European territory to incorporate a corporate

governance statement in their annual accounts. Companies are free to chose the code to which they

subscribe but they have to report on the application of the principles of that code within their company

on a comply or explain basis.4 The principle gives listed companies the possibility to either apply the

code`s principles and best practice provisions or, in case the application of the principles and best

practice provisions is not deemed desirable for that specific company, to deviate from these principles

and best practice provisions while giving a well reasoned explanation for such deviation. The

corporate governance code is complied with if either the standard rules have been applied or if there is

a well founded statement setting out the reasons for deviating from those standard principles.5

There are several reasons why the use of (soft law) codes in combination with the comply or explain

approach is preferable to rules of corporate governance vested in hard law. One of the advantages of

the use of codes is their flexibility. The provisions of corporate governance codes can easily be

adapted to new developments without the burden of having to go through a lengthy legislative

process.6 Next to that, the use of codes gives the boards of directors, supervisory board members and

shareholders the possibility to adjust their corporate governance to the specific needs of their own

enterprise. The use of codes leads to a more flexible approach to corporate governance allowing for

tailor made solutions. The comply or explain principle recognizes the necessity to deviate when

defining what constitutes good corporate governance. It is a recognition of the impossibility to

formulate a ‘one size fits all’ approach in this respect.7 The members of the management board, of the

supervisory board and the shareholders have to jointly agree on the corporate governance approach

most suitable for their company.8 The shareholders are often designated as the ultimate ‘watchdog’

4 Directive 2006/46/EC of the European Parliament and of the Council of 14 June 2006 amending Council

Directives 78/660/EEC on the annual accounts of certain types of companies, 83/349/EEC on consolidated

accounts, 86/635/EEC on the annual accounts and consolidated accounts of banks and other financial institutions

and 91/674/EEC on the annual accounts and consolidated accounts of insurance undertakings. 5 I. MacNeil and X. Li, “Comply or Explain”: market discipline and non-compliance with the Combined Code’,

Corporate Governance 2006, volume 14 nr. 5, p. 486. 6 I. MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined Code’,

Corporate Governance 2006, volume 14 nr. 5, p. 493-494. 7 I. MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined Code’,

Corporate Governance 2006, volume 14 nr. 5, p. 487; S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate

governance in the UK: Is the comply or explain approach working?’ International Review of Law and

Economics, 30 2010, p. 194; L. Enriques, H. Hansmann en R. Kraakman, ‘The Basic Governance Structure: The

Interests of Shareholders as a Class’, in: R. Kraakman c.s., The Anatomy of Corporate Law, Oxford University

Press 2009, p. 67. 8 S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate governance in the UK: Is the comply or explain approach

working?’ International Review of Law and Economics, 30 2010, p. 194. See also the reaction to the Green paper

by C. van der Elst en E.P.M. Vermeulen, ‘Corporate Governance 2.0: Assessing the Corporate Governance

Green Paper of the European Commission’, ECL 2011, p. 165-174.

3

with regard to corporate governance rules and their enforcement.9 It is in principle up to the

shareholders to raise their voice if they do not agree with the corporate governance approach set out by

the management board. In the Green paper the Commission asks if there is a need to design specific

corporate governance measures adjusted to the size of listed companies. Given the flexibility which

the comply or explain principle offers, this question seems to bypass the idea behind the comply or

explain principle. After all, the principle in itself already allows for deviations from standard best

practice provisions taking into account the specific internal structure, size and needs of a particular

company. However, this of course does not exclude the fact that it can be useful to formulate specific

standard principles which are more suited for smaller companies. The question is, however, whether

this is really necessary. That is also the view held by the majority of the respondents to the Green

paper. The respondents refer to the flexibility already offered by the comply or explain approach to

support their argument that a separate code for small companies is not necessary. They mention that it

is desirable to have the same corporate governance standards for all listed companies and not to have

certain companies fall within a subcategory. Furthermore, the difficulty to establish “meaningful size

criteria across the EU” was mentioned as a potential obstacle.10

The comply or explain principle originates from the United Kingdom and was introduced for the first

time by the famous Cadbury- report in the 90`s of the previous century.11

This report can be seen as

the predecessor of most contemporary corporate governance codes of the EU Member States. The

comply or explain principle fits well within the profile of the UK market at the beginning of the 1990s.

At that time the UK market was (and to a large extent still is) characterized by dispersed share

ownership, the presence of institutional investors, strong financial markets and an influential financial

press.12

Furthermore, the UK market operates within a common law tradition which was already to a

certain extent familiar with self regulation13

due to the fact that the UK Companies Act did not (and

still does not) provide many mandatory rules relating to the division of power between the

management board and the general meeting.14

The abovementioned characteristics have led to a

system in which enforcement is mainly delegated to the internal decision makers: the management

board and the shareholders meeting.15

The comply or explain principle fits well within such a system.

However, over the years the principle gradually spread across Europe with the adoption of national

corporate governance codes based on the UK example. This development took place without taking

into account the specific characteristics of the system from which the comply or explain principle

originated and without adapting it to the special needs of the legal tradition to which it was

transplanted. The question is therefore justified whether the comply or explain principle can

9 Report of the High Level Group of Company Law Experts on a Modern Regulatory Framework for Company

Law in Europe, 4 November 2002, this report can be found on

http://ec.europa.eu/internal_market/company/docs/modern/report_en.pdf; Study on ‘Monitoring and

Enforcement Practices in Corporate Governance in the Member States’, 23 September 2009, p. 183. 10

Feedback statement. Summary of responses to the Commission Green Paper on the EU corporate governance

framework, 15 November 2011, p. 5. (hereinafter also: the feedback statement). The statement can be consulted

on http://ec.europa.eu/internal_market/company/docs/modern/20111115-feedback-statement_en.pdf 11

See in this respect the study ‘Monitoring and Enforcement Practices in Corporate Governance in the Member

States’, 23 September 2009, p. 22; N. Haskovec, ‘Codes of Corporate Governance’, A Working Paper published

by the Millstein Center for Corporate Governance and Performance, June 2012, p. 7. 12

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 178. 13

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 178. 14

I. MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined

Code’, Corporate Governance 2006, volume 14 nr. 5, p. 486. 15

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 178.

4

effectively function within a system that lacks some or all of the abovementioned characteristic

features. Does the monitoring and enforcement of corporate governance by way of the comply or

explain rule require adjustment in order to be effective within a system with for example concentrated

instead of dispersed ownership? Other differences are amongst others the role of institutional investors

within the system and the differences in company models. Contrary to the UK, which uses a so called

(enlightened) shareholder model as point of departure, many continental systems in which the comply

or explain principle is used are build on a continental stakeholder model.

3. The effectiveness and potential drawbacks of the comply or explain rule in theory

The suitability of the comply or explain principle as a basis for corporate governance is not questioned

at the European level. The study on monitoring and enforcement practices in corporate governance in

the EU Member States, published in 2009, revealed that regulators, investors and companies widely

support the use of the comply or explain approach.16

The flexibility and the tailor made approach to

corporate governance, which is enabled by the use of the comply or explain principle, are much

appreciated features. However, as mentioned in the introduction to this paper, at the European level

questions are raised regarding the effectiveness of this system within the EU corporate governance

framework and some drawbacks of this approach have also been identified in academic literature.

Some of these drawbacks can be traced back to the fact that the comply or explain approach was

transposed from the UK to other legal systems without addressing the characteristics of those systems

which might have a negative influence on the effectiveness of the comply or explain approach.17

In

order to give recommendations with regard to measures to be taken in order to increase the

effectiveness of the comply or explain principle, we will first describe the potential drawbacks as

identified in academic literature. One of the things which have been identified as hampering an

effective comply or explain approach is the passive position taken by investors. The comply or explain

approach relies largely on enforcement by (often institutional) investors.18

However, not all markets

are characterized by such a large amount of institutional investors as the UK. Moreover, investors

often remain passive for several reasons. The passiveness can be caused by the free rider problem

which investors face. It can be due to a lack of knowledge and/or expertise or a lack of resources

enabling investors to overlook all corporate governance issues related to companies within their

portfolios. As mentioned above, the comply or explain approach emerged against the background of a

shareholder company law model and is therefore oriented towards creating shareholder value. Some

authors argue that one of the drawbacks of this system is that, given the fact that the framework is

primarily based on shareholder enforcement, there are not many possibilities to include stakeholder

interests.19

The absence of meaningful explanations when deviating from the best practices of a corporate

governance code is also an issue which is designated in academic literature as hampering the proper

16

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 12.; Green paper, p. 18. 17

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 12; Green paper, p. 18. 18

A. Steeno, ‘Note: Corporate Governance: Economic Analysis of a “Comply or Explain” Approach’, Stan. J.L.

Bus. & Fin. 2005-2006, p. 400; Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the

Member States’, 23 September 2009, p. 15; Green paper corporate governance, p. 11 and p. 19. 19

J. Parkinson en G. Kelly, ‘The Combined Code on Corporate Governance’, The Political Quarterly 1999, p.

101-107; S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate governance in the UK: Is the comply or explain

approach working?’ International Review of Law and Economics, 30 2010, p. 195.

5

functioning of the comply or explain principle.20

As was mentioned earlier, the goal of the comply or

explain principle is to enable companies to make use of a corporate governance form which is most

suitable for their organization and to enable them to use an approach which is tailor made and takes

into account the specific needs and characteristics of their company. This means that deviations from

standard corporate governance best practices are not problematic as long as they have their merit based

on the characteristics of the specific organization and are based on proper explanations. However,

these explanations in practice are often vague and the reasons for deviating from best practices are

often phrased in general terms not enabling shareholders, as the primary corporate governance

enforcers, to engage in a meaningful dialogue with the management board.21

Part of the problem can

be traced back to the abovementioned passive position taken by many shareholders. Some authors

suggest that shareholders are only willing to take an active stand regarding the chosen corporate

governance policy after periods of dissatisfaction and bad corporate performance.22

Shareholders often

use performance as an indicator of a company’s corporate governance quality. This means that

companies with low share prices which deviate from corporate governance best practices may be

punished by the market for such deviations without investors assessing the merits of such deviations.23

This can even be the case when deviations are in the interest of the company as a whole. If a company

wants to deviate from the corporate governance code it runs the risk that its investors do not agree with

that view.24

Therefore it is said that, instead of steering towards a meaningful dialogue between

investors and management board regarding the most suitable corporate governance structure, the

codes often enhance compliance. The comply or explain principle therefore runs the risk of in effect

leading to a ‘one size fits all approach’.25

Another aspect which has been identified in academic literature as well as in the corporate governance

Green paper as having a negative impact on the effectiveness of the comply or explain approach is the

presence of a dominant or controlling shareholder. As stated in the previous paragraph, the comply or

explain approach emerged out of a system which is traditionally characterized by dispersed ownership.

20

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 178; Green paper, p. 18-20. See also with regard to the situation in the UK I. MacNeil and X.

Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined Code’, Corporate

Governance 2006, volume 14 nr. 5, p. 489 and S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate governance in

the UK: Is the comply or explain approach working?’ International Review of Law and Economics, 30 2010, p.

193-201. See also in this respect N.K. Cankar, S. Deakin and M. Simoneti, ‘The Reflexive Properties of

Corporate Governance Codes: The Reception of the ‘Comply-or-explain’ Approach in Slovenia’, Journal of Law

and Society 2010, volume 37, nr. 3, p. 501-525. 21

I. MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined

Code’, Corporate Governance 2006, volume 14 nr. 5, p. 490. 22

See in this respect amongst others I. MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-

compliance with the Combined Code’, Corporate Governance 2006, volume 14 nr. 5, p. 492; S. Arcot, V.

Bruno, A. Faure-Grimaud, ‘Corporate governance in the UK: Is the comply or explain approach working?’

International Review of Law and Economics, 30 2010, p. 199 onwards. 23

L. Enriques, H. Hansmann en R. Kraakman, ‘The Basic Governance Structure: The Interests of Shareholders

as a Class’, in: R. Kraakman e.a., The Anatomy of Corporate Law, Oxford University Press 2009, p. 67 footnote

65 with reference to G. Hertig, ‘On-going Board Reforms: One Size Fits All and Regulatory Capture’, Oxford

Review of Economic Policy 2005, p. 273-274. 24

I. . MacNeil and X. Li, ‘“Comply or Explain”: market discipline and non-compliance with the Combined

Code, Corporate Governance 2006, volume 14 nr. 5, p. 487. 25

L. Enriques, H. Hansmann en R. Kraakman, ‘The Basic Governance Structure: The Interests of Shareholders

as a Class’, in: R. Kraakman e.a., The Anatomy of Corporate Law, Oxford University Press 2009, p. 67 footnote

65 with reference to G. Hertig, ‘On-going Board Reforms: One Size Fits All and Regulatory Capture’, Oxford

Review of Economic Policy 2005, p. 273-274. See also in this respect P. Coombes en S. Chui-Yin Wong, ‘Why

Codes of Governance Work’, The McKinsey Quarterly 2004, nr. 2, p. 53; N. Haskovec, ‘Codes of Corporate

Governance’, A Working Paper published by the Millstein Center for Corporate Governance and Performance,

June 2012, p. 11-12, p. 17.

6

However, contrary to the UK, most European continental systems are traditionally denoted as systems

with concentrated shareholder ownership.26

In general it is said that concentrated ownership leads to

better governance and a stronger monitoring of the management board.27

However, even though the

agency problem between the shareholders and the management may be smaller, the presence of a

controlling shareholder leads to a different kind of agency problem.28

The interests of the controlling

shareholder often do not run parallel to those of the minority shareholders. The controlling shareholder

may use (or even abuse) his power within the company to serve exclusively his own interest.29

Moreover, the minority shareholders often lack the ability to use shareholder power in order to

influence the corporate governance structure in such a way that their interests are taken into account.

According to some studies the presence of controlling shareholders has a negative impact on

transparency and leads to hampered explanations with regard to corporate governance deviations.30

The controlling shareholder is said to act as an insider who has little reason to make private

information public.31

However, academic literature is not unambiguous regarding the influence of a

controlling shareholder on corporate governance. Other research shows to the contrary that there is no

direct link between the quality of explanations regarding corporate governance deviations and the

presence of a dominant shareholder.32

It can be argued that within a company with a controlling

shareholder a different type of corporate governance is needed, a corporate governance approach with

more principles aimed at safeguarding minority shareholder interests. The comply or explain approach

does allow for such deviations depending on the internal structure and characteristics of a specific

company.33

It is questionable however, whether or not the minority shareholder can dispose of a

sufficient amount of power to demand such deviations.

4. An assessment of the functioning of the comply or explain rule in the Netherlands

In this part of our paper we will assess whether or not the abovementioned drawbacks of the comply or

explain approach as defined in academic literature influence the effectiveness of the comply or explain

26

L. Enriques en P. Volpin, ‘Corporate Governance Reforms in Continental Europe’, Journal of Economic

Perspectives 2007, volume 21 nr. 7, p. 117. However, it has to be noted that in our opinion there is not a strict

division between markets in terms of dispersed and concentrated ownership. Both types of ownership will be

present in each market and the type of ownership will differ from company to company. See also E. Mouthaan,

‘Corporate Governance Reform in the US and EU-Time for a Change’, European Company Law 2008, p. 124. 27

A. Steeno, ‘Note: Corporate Governance: Economic Analysis of a “Comply or Explain” Approach’, Stan. J.L.

Bus. & Fin. 2005-2006, p. 405; L. Enriques en P. Volpin, ‘Corporate Governance Reforms in Continental

Europe’, Journal of Economic Perspectives 2007, volume 21 nr. 7, p. 122. 28

L. Enriques en P. Volpin, ‘Corporate Governance Reforms in Continental Europe’, Journal of Economic

Perspectives 2007, volume 21 nr. 7, p. 117. 29

A. Steeno, ‘Note: Corporate Governance: Economic Analysis of a “Comply or Explain” Approach’, Stan. J.L.

Bus. & Fin. 2005-2006, p. 406; L. Enriques en P. Volpin, ‘Corporate Governance Reforms in Continental

Europe’, Journal of Economic Perspectives 2007, volume 21 nr. 7, p. 122; E. Mouthaan, ‘Corporate Governance

Reform in the US and EU-Time for a Change’, European Company Law 2008, p. 124. See with regard to the

relationship between majority and minority shareholders also Ronald J. Gilson, ‘Controlling Shareholders and

Corporate Governance: Complicating the Comparative Taxonomy’, 119 Harv. L. Rev. 2006 1641-1679. 30

S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate governance in the UK: Is the comply or explain approach

working?’ International Review of Law and Economics, 30 2010, p. 198 with reference to M. Becht, P. Bolton

en A. Roell, ‘Corporate Governance and Control’ in: G. Constantinides, M. Harris en R. Stulz (red.), Handbook

of the economics of finance, London: Elsevier Science. 31

S. Arcot, V. Bruno, A. Faure-Grimaud, ‘Corporate governance in the UK: Is the comply or explain approach

working?’ International Review of Law and Economics, 30 2010, p. 198. 32

Study on ‘Monitoring and Enforcement Practices in Corporate Governance in the Member States’, 23

September 2009, p. 14. 33

See with regard to the protection of minority shareholders in the Belgian corporate governance code A.

Steeno, ‘Note: Corporate Governance: Economic Analysis of a “Comply or Explain” Approach’, Stan. J.L. Bus.

& Fin. 2005-2006, p. 406 ff.

7

principle in practice in the Netherlands. We have investigated to what extent three of the

abovementioned drawbacks surface in Dutch listed companies, in this respect we have looked at: the

alleged passive behavior of investors, the explanations given in case of deviations from corporate

governance principles and the functioning of the comply or explain rule in companies with controlling

shareholders. The research design for each of these topics will be further elaborated on below. The

Netherlands has had 8 years of experience with the mandatory application of the corporate governance

code for listed companies on a comply or explain basis. Before presenting the results of our research,

we will give a brief overview of the corporate governance framework in the Netherlands, the

shareholder structure of the Dutch listed companies and the influence of so-called

“administratiekantoren” (Trust Offices) on the shareholder structure. All of these issues are of

importance when assessing the functioning of the corporate governance code on a comply or explain

basis in the Netherlands.

4.1 Dutch corporate governance framework

On 1 August 2012 the Netherlands counted 106 Netherlands-based companies whose shares are listed

on the Euronext Amsterdam Stock Exchange. The market capitalization of these listed companies is

around € 430 billon which corresponds with approximately 70% of Dutch GDP. The Dutch listed

companies have a more international and dispersed ownership structure than most continental

European countries. At the end of 2010, an average of 76% of the shares of the Netherlands-based

‘blue chips’, the most traded companies in the leading stock exchange’s index (‘AEX’), were held by

foreign investors, about 50% were investors incorporated in the US and UK. Of the largest Dutch

listed companies, only 20% have a controlling shareholder (meaning more than 30% of the voting

rights; 30% voting rights is the threshold for the mandatory launch of a public bid for all the shares).

Most companies have a largest shareholder who owns between 5 and 30% of the voting rights.

However, in these figures, so-called Trust Offices (“administratiekantoren”) have not been counted.

Taking these Trust Offices into account will make the analysis of the shareholder structure of Dutch

listed companies a bit complex as will be discussed below. Before we get into that, we will briefly

explain the role of Trust Offices in this context as they are a typically Dutch phenomenon.

Table 1: shareholder structure of 20 largest Dutch listed companies (figures on 1 August 2012)

Largest shareholder Excluding Trust Offices

(depositary receipts)

Including Trust Offices

(depositary receipts)

More than 30% voting rights 20% 35%

10-30% voting rights 40% 35%

5-10% voting rights 35% 30%

Less than 5% voting rights 5% 0%

Source: notification register of the Netherlands Authority for the Financial Markets

Listed companies can choose to issue all or a large proportion of their common shares to a Trust

Office which in turn issues certificates of shares (or depositary receipts) to investors. Only the

certificates of shares are listed and can be bought by the public. The certificates of shares do not entitle

its owner to voting rights. However, they do entail a right to dividend. Voting rights can instead be

exercised by the Trust Office. However, since 2004 Trust Offices are legally obliged to grant voting

proxies in non hostile takeover situations (in so-called ‘peacetime’) to holders of certificates of shares

who so request. The holders of certificates of shares thus authorised can exercise the voting rights at

8

their discretion. The Trust Office will exercise the voting rights for those holders of certificates who

do not request a proxy to vote. With an average turn-out of holders of certificates of shares of around

50-60%, the Trust Office has still a large influence on the voting outcome. In hostile takeover

situations Trust Offices have the legal possibility not to grant voting proxies to holders of certificates

of shares. However, the Dutch corporate governance code recommends companies not to make the

distinction between ‘peacetime’ and ‘wartime’ situations, so that Trust Offices shall, without

limitation and in all circumstances, grant proxies to holders of certificates of shares who so request

(best practice provision IV.2.8). 3 out of the 20 largest companies have their ordinary shares

transferred to a Trust Office. If Trust Offices are included in the figures (as they on average count 40

to 50% of the votes at general meetings of shareholders), the largest Dutch companies have a more

concentrated shareholder structure, although still a majority (65%) does not have a controlling

shareholder (table 1).

The boards of Dutch listed companies typically have a two-tier structure: a supervisory board and a

management board. The role of the supervisory board is to supervise the policies of the management

board and the general affairs of the company and its affiliated enterprise, as well as to assist the

management board by providing advice. The role of the management board is to manage the company.

In discharging their roles, the management board and supervisory board shall be guided by the

interests of the company and its affiliated enterprise, taking into account the relevant interests of the

company’s stakeholders. The interests of shareholders do therefore not take priority over the interests

of other stakeholders: the Netherlands has a stakeholder model. As a consequence, strategy setting and

strategy execution are management board responsibilities, under supervision of the supervisory board.

The boards are accountable to the shareholders meeting for setting and executing the company’s

strategy, but the shareholders do not have formal rights in this field.

In addition to the Dutch company law framework, the Dutch corporate governance code came into

effect in 2004. The code was the Dutch response to the bankruptcies of a number of large Dutch

companies (e.g. KPNQwest), some controversial accounting scandals (e.g. Royal Ahold) and the

increase in payment packages of some members of the management board. The objective of the code

was to improve the checks and balances within listed companies. The code tried to realise this

objective by reinforcing the position of the supervisory board and that of the shareholders’ meeting.

The 'comply or explain' principle has also been embraced in Dutch company law since 2004. Dutch

listed companies are required by law to indicate in their annual accounts the extent to which they have

observed the principles and best practice provisions of the Dutch corporate governance code. Next to

the internal monitoring role given to shareholders and the supervisory board, the enforcement of

corporate governance codes is to a certain extent delegated to external monitoring forces such as the

external auditor, the Dutch securities supervisor, the Netherlands Authority for Financial Markets

(AFM) and the Corporate Governance Code Monitoring Committee. The external auditor has to check

whether such a corporate governance statement has been inserted in the annual report and also the

AFM supervises compliance with the legal annual report requirements. In addition to these bodies,

which ‘only’ check the availability of a ‘corporate governance code compliance statement’, a

Corporate Governance Code Monitoring Committee has been set up to monitor compliance with the

code. The Monitoring Committee publishes each year a monitoring report, reflecting on the level of

compliance by Dutch listed companies in general with the code.

4.2 Shareholder activity

9

The effectiveness of the comply or explain rule can be deducted from the extent to which shareholders

are willing to hold the management board and supervisory board members responsible with regard to

the application and possible deviations from corporate governance codes. We have identified three

issues from which the ability and willingness of shareholders to actively participate in corporate

governance enforcement on a comply or explain basis can be deducted. These three issues are the

following: i. the activity of shareholders in terms of voting, raising questions and making comments at

general meetings, ii. the willingness of shareholders to place items on the agenda of the general

meeting and iii. the willingness of shareholders to start legal proceedings in order to further

investigate a company`s corporate governance approach. We have looked at the activities of

shareholders of Dutch listed companies regarding these three aspects in order to answer the question

whether shareholders in practice live up to their role as ultimate corporate ‘watchdog’.

It is evident from graph 1 that shareholder engagement with the day-to-day affairs of Dutch listed

companies has increased greatly since the Dutch corporate governance code came into being (2004).

Growing numbers of shareholders take part in voting on important corporate governance items on the

agenda such as the appointment of members of the management board and supervisory board, the

discharge of the management and the supervisory board from liability, and amendments to the articles

of association.

Graph 1: average shareholder participation at the annual general meetings of the largest (‘AEX’)

Dutch listed companies and the middle-sized (‘AMX’) companies

The Dutch Corporate Governance Code Monitoring Committee had surveys carried out of corporate

governance-related shareholder activities at shareholders’ meetings over a number of years. Table 2

shows that hundreds of questions were asked every year and comments were made about corporate

governance in general and the Dutch corporate governance code in particular. It is interesting to note,

however, that the number decreased in 2008. One possible explanation for this may be that five years

after the code came into force, most listed companies had ensured that their corporate governance

structure was in better shape.

10

Table 2: numbers of questions asked and comments made about corporate governance and the Dutch

corporate governance code during general meetings at Dutch listed companies34

2005 2006 2007 2008

Number of questions about corporate

governance

- 713 720 522

Number of questions about the Dutch

corporate governance Code

400 323 299 177

Comments about corporate governance - 457 468 367

Total number of questions and

comments about corporate governance

- 1170 1188 889

The questions asked and comments made at general meetings about the application of and departures

from the Dutch corporate governance code led in a number of cases to the general meeting’s rejection

of resolutions proposed by the management of the company or to the withdrawal of these proposals.

This happened in 2008 for example, to the proposals for changes to the remuneration policies at

Philips, VastNed Retail and Corporate Express. The principal objection of shareholders in these

enterprises related to the absence of challenging performance criteria in the granting of variable

components of remuneration, one of the core principles of the code (principle II.2).35

In 2011 the

general meeting at TNT did not grant discharge from liability to the supervisory board, for reasons

including the non-application of best practice provision IV.1.136

by TNT Express – the TNT division

that was floated on the stock exchange in 201137

. In 2010 a proposal from the ING Groep concerning

the manner of implementing the revised Dutch corporate governance code was only passed with the

‘assistance’ of the ING Groep Trust Office. A large majority of the holders of depositary receipts for

shares in ING, who themselves took part in the decision-making process on the grounds of a voting

proxy from the trust office, voted against the way in which the bank-insurer was intending to

implement the code.38

Shareholders did not only ask questions about, make comments on and vote on corporate governance

proposals prepared by the corporate management, they also took the initiative in placing corporate

governance subjects on the agenda in a number of cases. Between 2005 and 2012 shareholders made

use of the right to have issues placed on the agenda in a total of forty cases, eighteen of which

involved the important corporate governance subjects of the dismissal and appointment of members of

the management board and supervisory board.39

In one case a code provision was explicitly placed on

the agenda, viz. the discussion of best practice provision IV.1.1. A shareholder at ASM International

asked the management board and supervisory board in 2006 to explain to the general meeting during

34

Source: the surveys of shareholder activities in 2006, 2007 and 2008 commissioned from Rematch Holding by

the Corporate Governance Code Monitoring Committee (can be downloaded at www.corpgov.nl). 35

R. Abma, ‘Ontwikkelingen in het aandeelhoudersvergaderingenseizoen 2008’, Tijdschrift voor

Ondernemingsbestuur 2008, no. 5, p.109-117. 36

Best practice IV.1.1 relates to the procedure for the dismissal and appointment of members of the management

board and of the supervisory board. 37

R. Abma, ‘Kroniek van het seizoen van jaarlijkse algemene vergaderingen 2011’, Ondernemingsrecht, 2011,

74, p. 367-375 (issue 10/11). 38

R. Abma, ‘Kroniek van het seizoen van jaarlijkse algemene vergaderingen 2010, Ondernemingsrecht, 2010,

109, p. 526-536 (issue 13). 39

R. Abma, ‘Kroniek van het seizoen van jaarlijkse algemene vergaderingen 2010, Ondernemingsrecht, 2010,

109, p. 526-536 (issue 13), with additional information from R. Abma, ‘Kroniek van het seizoen van jaarlijkse

algemene vergaderingen 2011’, Ondernemingsrecht, 2011, 74, p. 367-375 (issue 10/11).

11

discussion of that agenda item why it was not being proposed to bring the articles of association of the

company into line with best practice provision IV.1.1. of the Dutch corporate governance code.40

A last indicator of shareholder interest in corporate governance subjects is the surfacing of issues

regarding the corporate governance structure and the provisions in the Dutch corporate governance

code in legal proceedings. Shareholders may take various types of legal action, such as starting an

inquiry procedure before the Enterprise Chamber of the Amsterdam Court of Appeal, the court in the

Netherlands which specialises in settling disputes between shareholders and the management board of

the company. Various stakeholders (e.g. trade unions and shareholders representing at least 10% of the

issued share capital or with a par value of € 225,00041) may request the Enterprise Chamber an inquiry

if there are sound reasons to doubt the policies of the company and/or the conduct of its business. In

assessing whether the board’s behavior has amounted to ‘mismanagement’, the Enterprise Chamber

also takes into account the extent to which the code principles and best practice provisions are

followed. The following lawsuits brought by shareholders are examples of proceedings in which

provisions of the code played a role: Versatel42

(issues including the provisions relating to conflicts of

interest), ABN Amro43

(issues including the provisions relating to the division of powers between the

management board and the general meeting, and concerning severance pay) and ASM International44

(issues including the provisions relating to the procedure for the appointment and dismissal of

members of the management board and members of the supervisory board, and concerning the role of

the supervisory board).

It may be concluded from the indicators considered above that shareholders in Dutch listed companies

believe that corporate governance is an important subject. They asked numerous questions and made

numerous comments on and during discussion of this subject at general meetings of shareholders,

which sometimes resulted in the rejection of resolutions proposed by the management board and the

supervisory board. Shareholders themselves also used their right to put an item on the agenda of

general meetings in order to address corporate governance issues. They started legal proceedings in a

number of cases, in order to obtain a court ruling in disputes relating to issues including the corporate

governance structure of the enterprise in question, and/or the failure to apply provisions in the code. It

would appear, therefore, that shareholders have taken good heed of the Dutch Corporate Governance

Committee’s call in 2003 to exercise the rights available to them (in the general meeting of

shareholders and otherwise), including legal action, in the event of deadlock on important corporate

governance issues.45

40

See explanatory notes to agenda item 20 for the general meeting of ASM International on18 May 2006

(www.asm.com). 41

On 12 June 2012 the Dutch Senate passed a Bill that amends the corporate inquiry procedure. The Bill will

a.o. change the access to the inquiry procedure by shareholders of large companies (issued share capital of more

than € 22.5 million). At these companies the requesting shareholder needs to hold 1 percent of the issued share

capital or a € 20 million interest (market value) in the company. The Bill will enter into force on 1 January 2013. 42

Supreme Court of the Netherlands [hereafter HR] 14 September 2007, Jurisprudentie Onderneming & Recht

[hereafter JOR] 2007, 238, legal ground 3.2 and legal ground 4.4.3. 43

HR 13 July 2007, JOR 2007, 178, legal ground 4.4, and Amsterdam District Court, 29 December 2008, JOR

2009, 26, legal grounds 1.7, 1.8, 1.21 and 29. 44

HR 9 July 2010, JOR 2010, 228, legal grounds 3.1, 3.4.8, 4.4.2 and 4.5.1 and Enterprise Division of the

Amsterdam Court of Appeal [hereafter OK] 14 April 2011, JOR 2011, 179, legal grounds 3.14 and 3.17. 45

See also Organisation for Economic Co-Operation and Development, “Peer review 4: Board Nomination and

Election”, June 2012, p. 71. (DAF/CA/CG(2012)1/FINAL).

12

4.3 Soundness of reasons given for instances of non-application of the corporate governance

code’s best practice provisions

Another critical factor in the effectiveness of the comply or explain rule is the provision by listed

companies of serious reasons for non-application of provisions of the code. It is stated in the preamble

to the Dutch corporate governance that non-application is not objectionable in itself, but these

instances of non-application should be based on “specific circumstances of the company and its

shareholders” as described in the same paragraph. Non-application must, therefore, have specific and

not generic grounds.

In order to express an opinion on the situation in the Netherlands, we have scrutinized the reasons

provided for the non-application of a number of best practice provisions, specifically those which are

often not applied,46

i.e.: best practice provisions II.1.1 (maximum period for which members of the

management board are appointed) 47

, II.2.8 (maximum severance pay for members of the management

board), III.3.5 (maximum period of appointment for members of the supervisory board) and IV.1.1

(requirements for the general meeting to be able to cancel a binding nomination for appointment

and/or to dismiss members of the management board and members of the supervisory board). We have

made an inventory of the non-compliance and the explanations given for non compliance with the

above-mentioned best practice provisions in the financial year 2010 by the hundred largest Dutch

listed companies.

Table 2: nature of the explanations provided by companies that did not apply certain best practice

provisions (total number of companies studied: 100)

II.1.1 II.2.8 III.3.5 IV.1.1

Generic

explanation

13 17 9 9

Maintenance of

flexibility

3 7 5

Specific

explanation

2 2 1

No explanation 3 18

Note: we define “generic explanation” as explanation based on arguments that the Dutch Corporate

Governance Committee had already taken into account when drafting the final version of the code, as

apparent from the ‘Account of the Committee’s work’ (appendix to the 2003 Dutch corporate

governance code) This type of explanation therefore does not specifically focus on the company’s

situation.

Under “maintenance of flexibility” we classify explanations such as: the relevant provision of the

code is applied “in principle” or “in essence”, but the company still wishes to retain the freedom to

be able not to apply the provision in specific circumstances.

Under “specific explanation” we range explanations that focus on the specific circumstances of the

company.

The classification “no explanation” means that we have found no explanation for an instance of non-

application in the corporate governance paragraph or statement.

46

Corporate Governance Code Monitoring Committee, ‘Second report on compliance with the Dutch Corporate

Governance Code’, December 2010, table 1, p. 18-19. 47

We have not classified ‘Existing cases’ ( i.e. terms of office of members of the management board who were

already members before the Dutch corporate governance code came into operation in 2004) as non-application,

as these cases are sanctioned by the code.

13

Table 2 shows that only a limited number of companies relate the reasons for deviating from the best

practices to the specific situation of the company in question. In the majority of cases in which the

code has not been applied either a generic explanation is all that is provided or no explanation

whatsoever is given. The latter choice occurs relatively often in the case of non-application of best

practice provision IV.1.1, which means that companies are acting in violation of the law.48

Our finding on this component is that in the great majority of cases of non-application, the reasons

have been formulated in general terms, a disclaimer has been incorporated, or no reasons whatsoever

have been provided. This finding confirms the critical comments on the comply or explain rule

expressed in the literature, which were discussed in paragraph 3. The lack of explanation does not

contribute to the confidence of society, shareholders and other stakeholders in the effectiveness of the

comply or explain rule.49

4.4 The effectiveness of the comply or explain principle in case of controlling ownership

We stated in paragraph 3 that the comply or explain rule may prove ineffective within companies

characterized by one or more controlling shareholders. In order to investigate this, we examined the

reasons provided for non-application of certain specific best practice provisions. These best practice

provisions concern: the required level of independence of the supervisory board (best practice

provision III.2.1), the period for which members of the supervisory board may be appointed

(maximum of 12 years; best practice provision III.3.5) and the functioning of the Trust Office in case

depositary receipts have been issued and listed (best practice provisions under section IV.2). These are

precisely the provisions for which we would expect to find relatively frequent non-application when

controlling shareholders do not take the provisions of the code seriously. We can well imagine that

controlling shareholders would want seats on the supervisory board and would consequently be less

inclined to comply with the maximum term of office imposed by the code. In addition, we can imagine

that the major shareholder in companies that have issued depositary receipts , i.e. the trust office, may

find it difficult to relinquish its “power” voluntarily. Let us first look at the composition of the Dutch

market in terms of concentrated ownership. In this context, we define a controlling shareholder as a

shareholder that holds an interest that is greater than 30%, because the legislature assumes that a party

that has reached a percentage on this scale has a controlling interest in a company and has an

obligation to make a public offer for all the shares.50

48

We arrive at 28 instances of non-application of best practice provision IV.1.1, while the Dutch Monitoring

Committee arrives at a total of 16 in its monitoring report of December 2010 (for the financial year 2009). This

leads us to suspect that the Dutch Monitoring Committee relies only on the corporate governance report provided

by the company and that no check is made of whether this report is consistent with other public sources of

information, such as articles of association and press releases. 49

The quality of the explanations of non-application by Dutch companies actually compares favourably with

those provided by many companies registered in other EU member states (Study of ‘Monitoring and

Enforcement Practices in Corporate Governance in the Member States’, 23 September 2009, p. 14, which can be

consulted at http://ec.europa.eu/internal_market/company/ecgforum/studies_en.htm). 50

Section 5:70 in conjunction with section 1:1 of the Netherlands Financial Supervision Act (Wft). Parties which

had a pre-existent controlling interest at the time when this statutory obligation entered into force are exempted

from the obligation to make a public offer, as are parties that hold a controlling interest at the moment the shares

of the company in question are introduced on a stock exchange (‘IPO’). The control threshold stipulated by the

legislator does not alter the fact that shareholders with an interest of less than 30% already have actual control

over companies with widely dispersed share ownership and limited shareholder participation in the decision-

making at shareholders’ meetings.

14

Twenty-six of the one hundred companies surveyed have one or more controlling shareholders, not

including trust offices. Fifteen companies have placed (a quantity of) their ordinary shares with a trust

office and have only listed the depositary receipts on a stock exchange.

The findings for best practice provisions III.2.1 and III.3.5 are presented in table 3.

Table 3: number of instances of non-application of best practice provisions III.2.1 and III.3.5 by the

26 companies with one or more controlling shareholders

III.2.1 III.3.5

Non-applications 4 (= 15%) 6 (23%)

In the case of the four companies that do not apply best practice provision III.2.1 and that have one or

more shareholders with a controlling interest, non-application is also connected with the fact that one

or more members of the supervisory board are associated with the controlling shareholder in question.

The reasons given for non-application refer to the stipulated rights of the controlling shareholder, or

the company’s belief that knowledge and experience are more important than independence. A total of

ten of the whole population of companies surveyed do not apply best practice provision III.2.1. Of the

six companies reporting non-application of best practice provision III.3.5 that are characterized by one

or more controlling shareholders, there is one company where the non-application is connected with

the fact that the supervisory director who is associated with the major shareholder has held this

position for longer than 12 years. As is shown in table 2, a total of nineteen out of the one hundred

companies surveyed report non-application of best practice provision III.3.5.

Four (27%) of the 15 companies that have issued depositary receipts for (a quantity of) their ordinary

shares report non-application of the provision that the Trust Office will issue proxies to the holders of

depositary receipts under all circumstances. In the reasons provided for this non-application, two

companies refer to existing legislation and the other two refer to the necessity of protecting the

company on account of its size or of safeguarding the confidential nature of the information from

customers. These are not company-specific reasons. The other eleven companies have ended the

protective nature of the issue of depositary receipts in the last few years.

It may be concluded from these findings that a number of companies with controlling shareholders do

indeed fail to apply important provisions intended to protect minority shareholders against the ‘power’

of the controlling shareholder. It should be noted in this context, however, that this refers to a minority

of the companies monitored and that the number of instances of non-application of these provisions is

no greater (is actually smaller in fact) than it is within companies that lack a controlling shareholder.

In addition, a large majority of the companies which had issued depositary receipts has decided either

voluntarily or under pressure from the Dutch corporate governance code to abolish the protective

nature of issuing depositary receipts and have themselves curtailed the power of the controlling

shareholder by doing so. We therefore see no need to introduce additional rights or best practice

provisions aimed at protecting minority shareholders against the controlling shareholder. This opinion

is shared by the majority of the respondents to the European Commission’s corporate governance

green paper.51

5. Towards a more effective comply or explain principle

51

Feedback statement, p. 16.

15

The analysis in paragraph 4 shows that the shareholders in Dutch listed companies consider corporate

governance and compliance with the Dutch corporate governance code to be important subjects. This

can be partly contributed to the pressure that has been exerted in the past and that still rests on the

shoulders of institutional investors stimulating them to take an active stance with regard to corporate

governance issues.52

Another factor which may have contributed to this shareholder activity may be

the easy access to court proceedings and rulings related to the internal governance of companies in the

Netherlands. The Enterprise Chamber does take corporate governance practices and principles into

account when deciding a deadlock situation between various stakeholders within the company.53

Despite the active position taken by shareholders, they at the same time are apparently not able to: i)

force companies to provide sound reasons for significant instances of non-application of code

provisions; and ii) to call companies to account for failing to report an instance of non-application

when this non-application has become evident from other sources of information. There is no

(statistical) difference in this respect between companies controlled by one or a small number of

shareholders and companies with widely dispersed share ownership. We conclude that the absence of

reports on non-application and the inadequate solidity of the substantiation for non-application are,

therefore, the most important obstacles to the effectiveness of the comply or explain rule in the

Netherlands. In this paragraph we will examine whether there are possible ways of eliminating these

obstacles. We will successively consider the role of the external auditor, the role of the public

supervisor, the strengthening of the role of the shareholder and the extension of the task of the Dutch

Corporate Governance Code Monitoring Committee.

5.1 Extending the task of the external auditor

Section 2:393 paragraph 3 of the Dutch Civil Code[DCC] requires the external auditor to examine

whether the annual report has been prepared in accordance with the statutory requirements and is

consistent with the annual accounts. Section 3c of the Decree establishing further regulations for the

contents of the annual report54

specifies the review of the corporate governance statement by the

external auditor. The external auditor must verify whether a listed company has included the following

information in its annual report:

a) a statement on compliance with the principles and best practice provisions of the Dutch corporate

governance code addressed to the management board or the supervisory board;

b) reasons for (intended) non-application of principles and best practice provisions contained in the

Dutch corporate governance code.

The Netherlands Institute of Registered Accountants, the Royal NIVRA, clarified in a practical

guide55

that when (some of) the information referred to above is absent, this must be reflected in the

auditor’s report. The Royal NIVRA distinguishes the following situations in this respect:

i) there are shortcomings in the annual report, e.g. not all of the code provisions have been

applied and the reasons for this have not been included in the annual report;

52

The Dutch corporate governance code also contains provisions concerning the responsibilities of institutional

investors (principle IV.4). They are required to publish their policy on the exercise of voting rights on shares

they hold in listed companies on an annual basis, report on how they have implemented that policy and report on

how they have voted. See also Organisation for Economic Co-Operation and Development, “Peer review 4:

Board Nomination and Election”, June 2012, p. 70. (DAF/CA/CG(2012)1/FINAL). 53

See also Organisation for Economic Co-Operation and Development, “Peer review 4: Board Nomination and

Election”, June 2012, p. 71. (DAF/CA/CG(2012)1/FINAL). 54

Decree of 23 December 2004 establishing further regulations for the content of annual reports (Stb. 747).

Most recently amended by Decree of 10 December 2009 (Stb. 545). 55

Practical guide 1109, ‘De verantwoordelijkheid van de accountant bij de toetsing van in het jaarverslag

opgenomen corporate governance-informatie, Royal NIVRA, 11 March 2010.

16

ii) the account given of the application of the provisions contains a material misstatement of

facts;

iii) the account given in the annual report with reference to the information on the application of

the code provisions contains material inconsistencies with the annual accounts.

The chairman of the Dutch Corporate Governance Code Monitoring Committee writes in the 2010

Monitoring Report that: “The Monitoring Committee is aware that the auditor’s role in monitoring

compliance with the Code by listed companies is unclear. Nonetheless, the Committee calls upon

auditors to hold the management board of the company to account if the Code is not complied with

(i.e. if it is not applied and no explanation is given).”56

The lack of clarity identified by the chairman

of the Monitoring Committee may relate to the question of how far the auditor should go in carrying

out a review, and specifically when answering the question of whether there is a “material

misstatement of facts” if the company does not report non-application of best practice provision IV.1.1

for example (see paragraph 4.2), while the articles of association do not reflect this application. In

other words, the question is: should the external auditor not only check whether the annual report

contains a corporate governance statement, but also whether the content of this statement is consistent

with other sources of information? In our opinion, this should be the case in the example quoted since

the omission of this non-application may mislead investors. The presence or dismantling of anti-

takeover schemes – increased thresholds for the right of the shareholders’ meeting to dismiss members

of the management and supervisory board can be placed in this category – have indeed proven to

influence share prices in the past. Correct information on this subject is of material importance for

investors. We therefore argue in favour of the external auditor also examining the corporate

governance statement for consistency with other public or non-public sources of information known to

the external auditor during its regular audit of the annual accounts. An examination of this nature

should always take place when information on the (non-)application of the relevant code provision

may influence an investor when making an investment decision. In our opinion, a check of this kind

follows from the instructions to the external auditor to verify whether the information in the corporate

governance statement provided by the company contains a material misstatement of facts.

We are not in favour of the work of the external auditor being extended to also include the verification

and assessment of the explanations for non-application of the code provisions. In the first place, a

review of this kind would require the external auditor to express an opinion on the quality of the

reasons provided, while the preparation of an opinion of this kind would require a separate assessment

framework, which is not (yet) available at present. An opinion on compliance with this assessment

framework would also be subjective to a great extent, which is not in line with the current role of the

external auditor. Furthermore, the external auditor would have to express an opinion on the question of

whether, in view of the situation of the company: i) the non-application is justified; and ii) to the

extent that there is no non-application, whether the application of the best practice provision does

justice to the specific circumstances of the company in question. The comply or explain rule is, after

all, intended to facilitate non-application if non-application would lead to better corporate governance

under certain circumstances (see paragraph 3 in this context). We do not believe that it is in line with

the terms of reference of the external auditor to give an opinion on the organization of the corporate

governance structure at the company in question. The external auditor would, in that case, be

expressing an opinion on the policy of the management board. We believe that this right must remain

56

Corporate Governance Code Monitoring Committee, ‘Second report on compliance with the Dutch Corporate

Governance Code’, December 2010, p. 7.

17

reserved to the supervisory board which, together with the management board, renders account to the

shareholders’ meeting in this respect.57

5.2 Extending the task of the public supervisory authorities

As previously mentioned, the AFM verifies whether annual reports of listed companies contain a

statement on compliance with the Dutch corporate governance code, as required by section 2a of the

Decree establishing further regulations for the contents of the annual report, in conjunction with

section 2:391 paragraph 5 DCC. In the Explanatory Memorandum to the Bill introducing public

supervision of financial reporting, the legislator comments that the AFM does not verify the contents

of the corporate governance statement.58

The AFM must, however, verify “whether the contents of this

statement are consistent with the contents of the rest of the annual report and with other public

information (consistency assessment). The AFM assesses, therefore, whether the content of the

statement is consistent, but not whether the content of the corporate governance statement is

substantively correct, or whether it demonstrates good corporate governance in the view of the AFM.

That is the responsibility of the AGM,” according to the legislator.59

It may be concluded from various AFM Activity Reports on the supervision of financial reporting and

also from the jurisprudence, that in every year since the AFM started supervising financial reporting, it

has notified a number of companies in writing that there are shortcomings in the corporate governance

statement and/or has recommended that the report on compliance with the Dutch corporate governance

code should be improved.60

In view of the passage quoted above from the explanatory memorandum to

the bill introducing supervision of financial reporting, we assume that these notifications and

recommendations did not refer to the soundness of the reasons for non-application. It is not clear from

the activity reports whether the notifications and recommendations referred (in part) to the lack of

consistency between the content of the corporate governance statement and other public information,

such as the articles of association.

The European Commission has suggested in its Green Paper that it would like to extend the role of

public supervisory authorities to include an assessment of the soundness of the explanations (see

paragraph 1). It is not clear how the European Commission envisages doing this. In line with our

comments in paragraph 5.1, a framework for the assessment of the soundness of explanations will be

necessary. Furthermore, the supervisory authority will have to become acquainted with the specific

circumstances of the company, if it is to arrive at a substantive opinion on how apposite the non-

application is. It is dubious whether a role of this kind is appropriate for a supervisory authority. Here

too, the initial question that has to be asked is whether it is advisable for a supervisory authority to be

given a substantive role in shaping or assessing the chosen corporate governance structure of listed

57

This does not alter the fact that the external auditor may have his own professional views on the quality and

effectiveness of the corporate governance structure of the company in question. The consequence of these views

could be taken into account in the auditor’s opinion and when considering whether an emphasis of matter or

other matters paragraph should be included. 58

Kamerstukken II 2005/06, 30 336, no. 3, p. 14 [Kamerstukken: Parliamentary Papers]. 59

On this subject also see J. Dinant, ‘Comply or explain; Publiekrechtelijk toezicht op de naleving van de Code

Tabaksblat’, Tijdschrift voor Jaarrekeningrecht, 2007, no. 4, p. 66-71. 60

See the AFM Activity Reports on Financial Reporting for 2007, 2008, 2009 and 2010, which can be consulted

at www.afm.nl, and OK 28 December 2007 (Spyker/AFM), JOR 2008, 38, legal grounds 3.58. The AFM has

sent a total of 22 notifications to listed companies, in which it is stated that there are reasons to doubt the correct

application of the reporting standards for the code (ranging from 9 in 2007 to 3 in 2010); also see Kamerstukken

II 2010/11, 22 112, no. 1220, p. 8.

18

companies.61

The European Commission has reached the conclusion in the interim that a role of this

kind is desirable in the case of financial institutions.62

We are extremely dubious about whether this

supervision should be extended to non-financial institutions. The structure and implementation of

corporate governance at listed companies, including decisions not to apply the best practice provisions

of the code, should primarily be and remain a matter for the management board, the supervisory board

and the shareholders63

possibly augmented by a corporate governance code Monitoring Committee

established on a self-regulatory basis, which provides recommendations and interpretations (see

paragraph 5.4). If defects in corporate governance are discovered, such as the inadequacy of

explanations for the non-application of code provisions, we believe that it is preferable for these

defects to be repaired by amendments to the internal division of powers within a company - including

the options for shareholders to participate in decision-making on the structure and implementation of

the governance - than to expect a supervisory authority to be the source of “salvation”.64

We do believe, however, that the public supervisory authorities could monitor more closely the

consistency between the contents of corporate governance statements and other public sources of

information.65

Our findings on the application of best practice provisions III.3.5 and IV.1.1 (see table

2) show that the enforcement of this point by the Dutch public supervisor has not yet produced

adequate results. In addition, it is recommended that the public supervisor explicitly discloses to the

outside world in its annual activity reports whether the notifications and recommendations sent

regarding compliance with the corporate governance code referred to: i) provision of inadequate

information in the annual report with regard to the application of the code provisions; ii) inconsistency

between the content of the corporate governance statement and other public sources; or iii)

inconsistency between the content of the corporate governance statement and the annual accounts.

5.3 Enhancing the role of shareholders

Shareholders of Dutch listed companies have a number of options at their disposal to call the

management board and the supervisory board of a listed company to account for the content of the

corporate governance statement. In the first place, they may ask questions to the management and the

supervisory board about the application of the code. As remarked in the preamble to the Dutch

corporate governance code, shareholders who do not agree with the extent of the company’s

compliance with the code, or who believe that the reasons given for non-applications are inadequate,

may, for example, decide in the general meeting not to discharge the management board and the

supervisory board from liability. They may furthermore decide not to adopt the annual accounts, to

amend or reject the remuneration policy of the management board, or to dismiss (members of) the

61

In this context also see P. Davies et al., ‘Response to the European Commission`s Green Paper “The EU

Corporate Governance Framework”’ European Company Law Experts, which can be consulted at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1912548. 62

See the European Commission’s proposal for a directive published on 20 July 2011 for enhanced capital

requirements and better corporate governance for banks and investment firms (‘CRD IV’), specifically the

proposed articles 86 to 91 inclusive (http://eur-

lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0453:FIN:EN:PDF). 63

An opinion shared by the Netherlands Minister of Finance in Kamerstukken II 2008/09, 31 083, no. 32, p. 25. 64

J.B.S. Hijink points out for example, that the Spanish supervisory authority has a major role in the monitoring

of compliance with the Spanish corporate governance code, while the quality of the explanations given by

Spanish companies is much lower than that of Dutch companies. See J.B.S. Hijink, Publicatieverplichtingen

voor beursvennootschappen (dissertation), Kluwer, 2010, p. 468. 65

Herein lies the difference with the task of the external auditor (see paragraph 5.1): when assessing consistency,

the auditor is also allowed to use non-public sources of information with which he is nevertheless familiar.

19

management board and the supervisory board. They also have the option of placing the extent of

compliance with the Code on the agenda as a point for discussion or as a voting item. They may

furthermore request the management and supervisory board to increase the level of compliance by

amending contracts of employment for example, and/or by preparing an amendment to the articles of

association. Shareholders may also take various kinds of legal action, such as starting an inquiry or

annual account procedure.66

We commented in paragraph 4.1 that shareholders have actually made use

of these rights in the last few years. It is dubious, however, whether shareholders’ rights should be

extended (further) in order to deal with the two defects identified in the effectiveness of the code

instrument. With reference to the first defect, i.e. the failure to report instances of non-application that

do actually exist, it is our opinion that there are important roles to be played here by the external

auditor and the public supervisor (see paragraphs 5.1 and 5.2). We also believe that shareholders have

a responsibility of their own to study the available documents thoroughly and to bring inconsistencies

to the attention of the management board, the supervisory board and the external auditor, at the general

meeting and otherwise, and to ask for clarification. The existing rights of shareholders to address the

general meeting of shareholders and to request information suffice. Where the second defect is

concerned, i.e. the lack of sound reasons for instances of non-application, we think that putting the

corporate governance statement to a vote at the general meeting would give the management board

and the supervisory board an incentive to provide better reasons.67

This applies all the more now that

the representation of shareholders at the general meeting has increased greatly in recent years (figure

1). The incentive is greatest when each non-application and reason is put to a separate vote, so that the

explicit opinion of the general meeting is asked for every instance of non-application. When the

general meeting is not convinced by the reasoning, we believe that the consequence of the failure to

obtain approval must be that the management board and supervisory board take measures to end the

non-application of the code. It is pointed out in the literature that members of a management board are

afraid to deviate from the best practice provisions of corporate governance codes out of fear for being

called to account by the shareholders, since it not clear whether the shareholders will take the same

view of instances of non-application (see paragraph 3). We assume that this anxiety on the part of

members of management boards will be limited, in the case of Dutch listed companies in any event.

Considering the significant shareholder engagement in the Netherlands with the subject of corporate

governance (see paragraph 4), it would seem logical to expect that shareholders will approve non-

application when the company’s management provides cogent company-specific arguments for this

and that approval is in the company’s interest. Submitting non-applications for a vote to the

shareholders’ meeting enables a management board to test its decision in advance, so that it does not

have to await the market’s reaction to the non-application, which may turn out to be negative. The

shareholders are requested to form a substantive opinion on the question of whether full application of

the code really is appropriate for the company in question, and on the quality of the explanation of the

non-applications with the best practice provisions. Their opinion is something from which the quality

of corporate governance may benefit, if the shareholders also carry out this task conscientiously. To

the extent that a shareholder believes that it is in the interest of the company not to apply one or more

best practice provisions, notwithstanding the views of the management board, this shareholder is free

to place this matter on the agenda for a shareholders’ meeting. If this shareholder succeeds in winning

66

Each shareholder of a Dutch listed company has the possibility to request the Enterprise Chamber of the

Amsterdam Court of Appeal to order that company to further explain its application of the statutory accounting

requirements (section 2:447 DCC). 67

A number of companies, such as Ballast Nedam, Beter Bed Holding, Fugro, Heineken, ING Groep, Sligro

Food Group and Wereld have actually done this in 2005, 2006 and 2010. The corporate governance statements

of these companies were approved by the shareholders’ meetings, although it should be noted in this context that

five of the said companies have a controlling shareholder (either a Trust Office or otherwise).

20

the support of a majority of the votes casted at the meeting, it is nevertheless dubious whether the

management board will follow a recommendation to this effect from the shareholders. The

management board has no obligation to do so, in our opinion, since the general meeting has no

authority to issue instructions. This is, however, a means by which shareholders can initiate a

substantive internal dialogue on corporate governance policy.

5.4 Naming and shaming by the Corporate Governance Code Monitoring Committee

When the Dutch corporate governance code came into force, the Dutch government appointed a

committee, known as the Dutch Corporate Governance Code Monitoring Committee, whose task it is

to ensure that the code is up-to-date and practicable.68

This committee, which is rooted in self-

regulation, reports annually on the application of the provisions of the code by listed companies and

institutional investors and is intended to identify gaps and ambiguities in the code and to express its

opinion in this respect, by formulating interpretations, guidelines or recommendations for example.

We believe that the formation of a committee of this kind has contributed to the permanent interest

that there has been in the subject of corporate governance in recent years. It has contributed to the

ability to provide relatively fast interpretations for ambiguities and consequently, to the development

of the code as a ‘living’ document. The formation of the Monitoring Committee has, however, been

unable to prevent the defects identified in paragraph 4. The Monitoring Committee itself has

acknowledged this and has announced, for example, that it is going to hold companies individually

accountable for non-compliance (the absence of an explanation for an instance of non-application) and

intends to improve the quality of the explanations for the non-application of code provisions.69

It is not

clear how it wishes to achieve this second objective.

We would like to recommend the Monitoring Committee to disclose the names of the companies that,

in the view of the Monitoring Committee, have not provided an explanation for non-application of the

code provisions or when the quality of the explanation is not satisfactory (‘naming and shaming’). The

potential loss of reputation with investors and customers that may ensue might induce companies to

comply with the code or to improve the soundness of the reasons given for non-application. It is

important in this context, however, for the Monitoring Committee to develop an assessment

framework for monitoring the quality of explanations and also to make this assessment framework

public.70

It should be noted that the Committee would only have to assess the explanations given for

non-application and not the soundness of the non-application itself. After all, providing an answer to

the question of whether non-application is preferable to compliance with the code is reserved to the

management board, the supervisory board and the shareholders. Before the Committee discloses the

name of a non-compliant company it will have to become acquainted with the specific characteristics,

structure and circumstances of the company in question. It is also important to point out that the

Monitoring Committee will have to apply the principle of hearing both sides and will have to give the

company the possibility to defend itself before taking it to the ‘Court of Public Opinion’.

6. Conclusion

In the Green Paper, the European Commission raises a number of questions concerning the

functioning of the comply or explain rule. This prompted us to carry out a further study of the

68

Stcrt. 14 December 2004, no. 241, p. 11. 69

Corporate Governance Code Monitoring Committee, ‘Second Report on Compliance with the Dutch

Corporate Governance Code’, December 2010, p. 15. 70

The Monitoring Committee could, for example, build on the experiment in the 2007 monitoring report to

assess the quality of the explanations provided (see Corporate Governance Code Monitoring Committee, ‘Third

Report on compliance with the Dutch corporate governance code’, December 2007, p. 33-35).

21

functioning of the comply or explain principle in the Netherlands. Significant factors influencing the

effectiveness of the comply or explain rule referred to in the literature are passivity and lack of interest

on the part of the shareholders, the lack of sound reasons for any non-applications of the code and the

dispersal of share ownership, in addition to the presence of controlling shareholders. Our study of the

effectiveness of the comply or explain rule in the Netherlands has shown, however, that the criticism

on the effectiveness of this approach as uttered in academic literature and by the Commission is only

true in part for Dutch listed companies. The shareholders in Dutch listed companies have

demonstrated, by asking questions and making critical comments, that they believe corporate

governance and the Dutch corporate governance code to be important subjects. In addition, companies

with one or more controlling shareholders do not score significantly worse for compliance with those

best practice provisions also intended to protect minority shareholders against controlling

shareholders. What our study does show, however - and this result is in line with the criticism in the

scientific literature - is that in a large majority of the cases in which a code provision has not been

applied, the reasons have been formulated in general terms, a disclaimer has been incorporated, or no

reasons whatsoever have been provided. These defects can be eliminated, in our opinion, when:

i) external auditors and the public supervisory authorities perform their tasks more stringently

and shareholders pay closer attention to the consistency between the content of the corporate

governance statement included by the company and other public sources of information, such

as articles of association, press releases and explanatory notes to agenda proposals;

ii) companies put each instance of non-application (and the reasons for this) to a vote at the

shareholders’ meeting;

iii) the Corporate Governance Code Monitoring Committee discloses the names of those

companies that provide no explanation for the non-application of code provisions or that

provide an explanation of unsatisfactory quality. The Monitoring Committee must, however,

draft and publish an assessment framework for this purpose.

All of this can be established within the boundaries of the existing legal infrastructure in the

Netherlands. Therefore, we come to the conclusion that in the case of the Netherlands there is no need

for more regulations or a greater role for the public supervisor, as suggested in the Green Paper.

Our analysis furthermore shows that the comply or explain method can be an effective corporate

governance tool also in other jurisdictions which do not all have the same characteristics as the UK

system, from which the principle originates. We have seen however that, in order to be effective, some

additional preconditions will have to be fulfilled and additional enforcement measures might have to

be taken. One of those preconditions is shareholder activity. Efforts undertaken in the Netherlands in

order stimulate institutional investors to take an active stance with regard to corporate governance

issues seem to have paid off and have resulted in a high level of shareholder activity. Another

important factor in this respect is in our opinion access to the court. The possibility for shareholders to

start an enquiry procedure at the Enterprise Chamber of the Amsterdam Court of Appeal has enhanced

corporate governance developments and has contributed to changing the behaviour of board members,

shareholders and external auditors. As we have indicated, the Enterprise Chamber has given rulings on

corporate governance issues. In terms of additional enforcement measures, the role of the Monitoring

Committee has to be emphasized. The reports of the Committee have contributed to the permanent

interest for corporate governance issues in the market. These prerequisites can be supplemented by the

abovementioned three additional measures in order to further enhance the effectiveness of the comply

or explain rule.